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The Sleeping Giant of Renewable Energy –
Mining the Earth’s Heat
• Political/social “stars aligning” for renewable resource development.
Increased government support in terms of tax incentives and policy
standards combined with social focus on clean, renewable energy sources.
• Geothermal is the “Rodney Dangerfield” of renewable energy.
Gets “no respect” but is an infinite resource providing long term revenues
with no fuel costs, near zero emissions & small environmental footprint.
• LT power purchase agreements (PPAs) drive predictable cash flow.
Access to capital is the key headwind today, but companies with proven
resources “behind pipe” and PPAs are better positioned for success.
• WWCM launches on the geothermal industry & Polaris Geothermal.
We are positive on this sector which provides cost competitive, renewable
power using mature technology. We expect investor interest to increase.
The Sleeping Giant of Renewable Energy – Mining the Earth’s Heat ........................................................................................1
Investment Summary and Outlook .............................................................................................................................................3
Mature, Cost Competitive Technology that Provides Long-Term Renewable Power; Leads us to be Bullish on this Sector.3
Investment Positives ...................................................................................................................................................................4
Investment Risks.........................................................................................................................................................................5
Geothermal Industry Overview...................................................................................................................................................6
First Geothermal Power Plant Created in 1904 in Italy ...........................................................................................................6
Massive Untapped Potential, but Hardly Scratching the Surface Today .................................................................................6
United States – The Global Leader in Geothermal Development............................................................................................9
United States – More than 100 Geothermal Projects in Development.....................................................................................9
United States – More is Needed to Realize full Geothermal Potential ..................................................................................10
Policy Environment ..................................................................................................................................................................11
Supply-Side Policy Objectives Supporting Renewable Energy.............................................................................................11
United States – Getting Its Act Together for Geothermal Expansion....................................................................................12
Bureau of Land Management – Removing Institutional Barriers ..........................................................................................14
Geothermal Energy Primer .......................................................................................................................................................15
Geothermal Sex Appeal........................................................................................................................................................15
Types of Geothermal Plants..................................................................................................................................................17
Enhanced Geothermal System Technology Could Drive Global Adoption...........................................................................19
Geothermal Project Development Cycle ..................................................................................................................................21
Can Take 4 to 6 Years for Geothermal Power Operations to Start ........................................................................................21
Geothermal Project Economics ................................................................................................................................................24
Many Favorable Characteristics ...........................................................................................................................................24
High Initial Capital Costs for a Solid Long-Term ROE ........................................................................................................24
Capital Costs ~ $3.5 Million to $4 Million per MW..............................................................................................................26
Operating Costs ....................................................................................................................................................................29
Geothermal Financing ..............................................................................................................................................................29
Project Financing/Construction Loans..................................................................................................................................30
Tax Equity – The Number of Providers has Shrunk Significantly.........................................................................................31
Appendix 1: Industry Players ...................................................................................................................................................33
Select Industry Players..........................................................................................................................................................33
A Greater Geothermal Ownership Role for Utilities?............................................................................................................38
Appendix 2: Investment Flows in Geothermal ..........................................................................................................................40
Geothermal Still a Small, but Growing Segment of Renewables ..........................................................................................41
Appendix 3: Investment Valuations..........................................................................................................................................43
Solid Correlation of Clean Energy Stocks with Oil Prices ....................................................................................................44
Canada, U.S. and Australia are Key Financial Markets for Geothermal Developers ............................................................45
Appendix 4: Geothermal – Why Less Respect? ........................................................................................................................49
The Rodney Dangerfield of Renewable Energy ....................................................................................................................49
Appendix 5: Cap-and-Trade versus Carbon Tax .......................................................................................................................50
A Market-Based System Designed to Cut Greenhouse Gas Emissions.................................................................................50
Appendix 6: Renewable Energy Credits...................................................................................................................................51
Appendix 7: Glossary ...............................................................................................................................................................52
Disclaimers ...............................................................................................................................................................................56
Investment Summary and Outlook
Mature, Cost Competitive Technology that Provides Long-Term
Renewable Power; Leads us to be Bullish on this Sector
Geothermal may be the most prolific, renewable fuel source that many
people have never heard of. While exploration risk exists in “proving up” a
geothermal resource, the advantages of geothermal are numerous. It is abundant
and reliable and has minimal environmental impact and high sustainability. It
can be used as a base load electricity source by utilities and has no fuel price risk.
Geothermal is amongst the least expensive options on a levelized cost basis, that
is, when compared with fossil fuel and alternative energy sources over the life of
a project (thus taking into account both capital costs and operating expenses).
While the technology is established (i.e. many geothermal plants in the U.S.
have more than 40 year operating histories) political, social, and economic
factors have started to align to the benefit of geothermal development. This
geothermal renaissance has been brought about by a convergence of factors
including volatile oil prices, the need to reduce dependence on foreign oil,
concern about climate change and greenhouse gases, and the growing need for
baseload generation. Against this backdrop, government incentives in the form of
tax credits and state laws mandating wider use of renewable energy have helped
spur development.
On the risk front, besides up-front exploration risk, geothermal is similar to
other renewable energy sources in that access to capital is the key risk factor
today. In addition, renewable energy sources today are dependant on long term,
supportive government policies in order to be economically viable.
Unfortunately, these policies are often affected by politics and economic swings.
While geothermal energy lacks a large pool of investors experienced with the
nuances of the resource development, we see this as an opportunity for those
willing to do their homework.
The renewable nature of the resource combined with mature technology and
20+ year power purchase agreements (PPA) with electric utilities, results in
highly predictable cash flows. A PPA is the legal contract between the
electricity generator and the customer (a utility or company buying the energy
capacity). The presence of a PPA significantly de-risks geothermal projects since
the capacity has been purchased which virtually guarantees future revenue
streams. While development timelines are longer than other renewable energy
sources such as wind or solar, attractive returns with levered IRRs often in the
high teens to thirties are achievable.
Given a tougher capital markets environment we believe industry
consolidation will accelerate. Many of the publicly-traded geothermal developer
companies are either pure-play geothermal companies or a division of a larger
energy company or utility. We expect larger companies will look to partner with
these developers for growth and to expand into additional renewable technologies
beyond solar and wind.
Investment Positives
Regulatory support for renewable energy is growing. There has been much
discussion concerning green technologies and action to reduce America’s
dependence upon foreign oil. The recent US$700 billion Emergency Economic
Stabilization Act of 2008 was passed with the condition that tax credits for
renewable energies be included in the Act. As part of his election campaign,
President Obama committed to spend US$15 billion a year over the next 10 years
on renewable energies and to ensure 10% of U.S. electricity comes from
renewable sources by 2012 and 25% by 2025. As part of the 2009 U.S. stimulus
package making its way through the Unites States House of Representatives and
the Senate, legislators are proposing numerous other renewable energy incentives
including extensions of production tax credits (PTCs) and loan guarantees.
According to Bloomberg, the Senate’s economic stimulus plan includes about
$78 billion overall for Energy Department programs or tax breaks for energy
projects. While not part of the stimulus package, President Obama has discussed
his desire to implement an economy-wide cap-and-trade program to reduce
greenhouse gas emissions by 80% by 2050. As a cap-and-trade system to control
carbon emissions will add additional financial burden, the future of renewable
energy will come down to political will.
Renewable base-load power. Unlike more popular wind and solar technologies,
geothermal resources are highly reliable, providing a minimum base-load
capacity factor typically in excess of 90%. Properly managed, geothermal sites
can provide energy for several decades. Natural ground water sources and the reinjection
of extracted geothermal fluids allow the replenishment of the
geothermal reservoir for a near-constant supply of heat energy available for
conversion to electricity.
Limited environmental impact. Total U.S. greenhouse gas emissions are
approximately 7.2 billion tons a year of which one-third comes from power
plants. Geothermal is amongst the greenest of the green renewable energy
sources and many projects can generate additional revenue from carbon credits.
Plants require a much smaller geographic footprint than wind or solar farms,
while emissions are low and are largely composed of water vapor.
Lowest long-term costs of all alternative energy sources. While developing a
geothermal resource is a timely endeavor and capital intensive, facilities have a
long life and low operating costs. Plants can be designed to operate in excess of
50 years. Once the project begins generating power, net margins can be in excess
of 65% since no hydrocarbon or radioactive fuels are required to generate steam
to drive the turbine. Levelized costs for geothermal electricity average 3¢ to 8¢
per kWh, which is cost competitive with wind and much cheaper than solar.
Enhanced Geothermal Systems (EGS) could significantly expand the realm
of viable development. EGS engineer the necessary conditions for geothermal
energy production by pumping water into the earth and fracturing the hot rocks
below. According to the U.S. Department of Energy, the potential increase in
geothermal capacity from EGS could be as much as a 40-fold improvement.
More than 30 EGS firms are engaged in exploration and development in
Australia.
Canadian developers have strong development pipelines with proven and
probable resources in place. Many have quality resource assessments, strong
management and project management capabilities. In this economic environment,
those with strong balance sheets will have the ability to fund the riskier
exploration activities to push pipelines forward. Notable Canadian-listed
geothermal developers include Polaris Geothermal Inc. (GEO-T), US Geothermal
Inc. (GTH-T), Nevada Geothermal (NGP-V), Western GeoPower (WGP-V), and
Sierra Geothermal (SRA-V) as well as privately-held Magma Energy Corp.
Investment Risks
Commodity pricing risk. Our research indicates a high correlation between
clean energy stocks and oil prices. While political and social sources are on side
for geothermal development, the slowing global economy, disastrous capital
markets, and substantial sell off in oil and gas prices may cause delays or
cancellation of geothermal projects. Simply put, the environment may play
second fiddle to the economy. The push towards alternative energy may slow as
fossil fuel prices have declined substantially.
Financing risk. Growth of geothermal developments requires considerable
upfront higher-risk exploration capital. Drilling wells can cost upwards of US$5
million to US$6 million with five to 10 wells often needed to prove that a
resource is economic. The construction of a geothermal plant costs
approximately US$4 million per MW of output. Development companies have to
access capital markets for financing to push projects forward. For projects in
development with a proven resource that can be debt financed, debt markets may
command yields that make IRRs less attractive to equity holders. While financing
is difficult now, there is a reasonable expectation that this will be better over the
next 12 to 24 months.
Technical risk. While geothermal energy has a long history and the technology
is proven, technical risks still exist. Key factors which determine the success and
cost of geothermal exploration and development include water temperature, rock
permeability, water chemistry, reinjection issues, make-up water availability, and
complex geology. The technical challenges are extracting the abundance of heat
economically.
Political risk. All companies are subject to regulatory issues which can impact
the economics of geothermal development. For example, governments (and their
agencies) in many cases may dictate factors such as tariff rates and income tax
holidays. These concessions could change with a new government regime and
could affect project economics for geothermal developers.
Project risks. Geothermal resources typically have a longer development cycle
from site selection to electrical generation, often spanning four to six years.
Several stages of development occur and each has unique risks that can delay or
cancel a project. These can include delays in permits (land, mineral, drilling,
environmental), drilling capacity shortage, improper resource assessment, long
lead times for drilling and turbine parts, PTC expiration, ineffective management
of the resource and project financing risks.
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